A tough road to economic recovery

“Our [OECD’s] base scenario is built on the premise that the
current freeze in short-term financial markets will be resolved in
a relatively short time span, but that bank deleveraging and
recapitalisation, as well as re-building of trust in the markets,
will take much more time,” said Schmidt-Hebbel.

He continued that the OECD expects a “significant weakening in
the world economy, with many OECD economies slipping into recession
sooner or later.” He added that economic recovery will be slower
than in recent economic downturns, though the actual pace of
recovery will depend largely on how quickly financial markets
resume transactions and lending, even if that lending remains
relatively restricted.

Schmidt-Hebbel also pointed to two risks in the OECD’s recovery
scenario. One of these would be if the current freeze in financial
markets and lending takes more time to “thaw out,” with more severe
effects on spending, output and employment. This would lead to a
deeper and more persistent recession, he warned.

The other risk the OECD sees comes from the as yet unknown
budgetary costs of governments’ rescue plans.

“When the financial crisis and recessions are behind us, fiscal
adjustment will be called for to maintain confidence in public debt
and currencies, particularly in those countries that have had to
foot high costs in bailing out their banks,” said
Schmidt-Hebbel.

Turing to how the world’s economy ended up facing the worst
economic crisis in eight decades, Schmidt-Hebbel had harsh words
for financial market participants and regulators.

“Where financial markets failed was in poor governance and the
structures of executive incentives that were inappropriate for the
stability of financial firms,” said Schmidt-Hebbel. “They failed in
the opacity of financial instruments and their trading, and a lack
of public information about balance sheets of financial
institutions and their off-balance sheet vehicles.”

On the issue of regulation, “omissions and failures were rife,”
he emphasised. “Many countries lacked comprehensive and unified
regulation of financial conglomerates, and their market
instruments, while capital regulation and accounting rules
exacerbated pro-cyclical bank leveraging and lending.”

Rating agencies also came in for yet another dose of criticism
with Schmidt-Hebbel accusing them of “weak oversight.”

He stressed that regulatory reform will aim to improve business
models, transparency, disclosure and oversight of financial
institutions.

However, he stressed: “While major regulatory changes of
financial and capital markets will be required, both nationally and
across countries, there is a clear and present trap to avoid, and
that is the risk of a regulatory over-reaction.”

He cautioned that excessive regulation can do damage by
inhibiting future financial innovations, market integration and
growth.

“We require better regulation, not just more regulation,” he
stressed.